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Should You Care About Arcos Dorados Holdings Inc.’s (NYSE:ARCO) Investment Potential?

Simply Wall St

Today we are going to look at Arcos Dorados Holdings Inc. (NYSE:ARCO) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Arcos Dorados Holdings:

0.083 = US$163m ÷ (US$2.6b - US$595m) (Based on the trailing twelve months to December 2019.)

So, Arcos Dorados Holdings has an ROCE of 8.3%.

Check out our latest analysis for Arcos Dorados Holdings

Does Arcos Dorados Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. It appears that Arcos Dorados Holdings's ROCE is fairly close to the Hospitality industry average of 8.5%. Aside from the industry comparison, Arcos Dorados Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Arcos Dorados Holdings's current ROCE of 8.3% is lower than its ROCE in the past, which was 13%, 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Arcos Dorados Holdings's ROCE compares to its industry. Click to see more on past growth.

NYSE:ARCO Past Revenue and Net Income April 26th 2020

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Arcos Dorados Holdings's ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Arcos Dorados Holdings has current liabilities of US$595m and total assets of US$2.6b. Therefore its current liabilities are equivalent to approximately 23% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

The Bottom Line On Arcos Dorados Holdings's ROCE

That said, Arcos Dorados Holdings's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Arcos Dorados Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.